What’s the outlook for the global energy transition?

Executive summary

Over the last few years, the narrative around the outlook for decarbonization has been predominately negative. The combination of cost-of-living pressures, tight oil and gas markets, and a swing toward more populism in several parts of the world has deprioritized climate on the political agenda. Considering that energy transition is a monumental undertaking that will span several decades, it is not surprising to see shifts in sentiment along the journey. After all, decarbonization is intrinsically linked to energy markets, which are famously volatile. 

An interesting aspect of energy transition is its emotiveness across society; special interest groups; politicians; and even, at times, investors. Energy transition is grounded in science and can be tracked with an enormous amount of data, but the topic has shown itself to be exceptionally vulnerable to sentiment, data mining, and media headlines. Of course, the idea of psychological influences challenging the rational actor theory is not new to financial markets; it just feels quite pronounced on this topic.

While understandably a lot of media attention is focused on the likely prospect of missing 1.5°C alignment targets as decarbonization is pushed down the political pecking order, not enough focus has been on the realistic range of options available to meet energy demand over the next 10 to 20 years. Additionally, not enough attention is given to the motivations of governments and the prospect for technological advancement, which has been repeatedly underestimated through the transition.

Our view is that the shift toward energy security has strong synergies with low- and zero-carbon infrastructure investment. For example, once installed, renewables can provide domestic energy production. In some countries, such as China, it is an economic growth driver (clean energy sectors contributed just over 10% of Chinese gross domestic product¹ in 2023). This white paper takes a step back to look at the underlying drivers of energy transition, the motivations of both the governments that will drive it and the industries that will carry it out, as well as the realistic options available to them.

Taking stock—Are we making any progress?

Measuring progress on energy transition is generally done by tracking global greenhouse gas (GHG) emissions against a 1.5°C-aligned trajectory. On this metric, progress is unequivocally not good. The reason is not due to lack of activity in zero-carbon energy; rather, it is that green infrastructure capacity has not been able to grow fast enough to meet energy demand. In markets where primary energy demand has stabilized or moved into decline, the greening energy mix is starting to materialize, and we are seeing a declining trend in absolute CO₂ emissions.

Another factor impeding progress has been that while green capital expenditure has grown at astronomical rates, it has done so from a very low base, so it has taken time for its incremental growth to take a noticeable amount of share from fossil fuel infrastructure investments.

The growth in renewables capacity additions, particularly solar, is driven by the decline in the levelized cost of solar production over time, which has steadily fallen at a faster rate than expectations. We may be at an inflection point when it comes to green energy sources and their ability to meaningfully impact the broader energy system. For example, in 2024, more than three‑quarters of global electricity demand growth was met with zero-carbon sources—solar (40%), wind (16%), hydro (16%), nuclear (6%), and other renewables (2%)—but fossil fuel generation was required to handle the remaining 21% of incremental demand.² The biggest reason why fossil fuel generation was needed was exceptional weather demand; in a normal weather year, the call on fossil fuel generation to meet incremental demand growth would only have been 4%.²

Unfortunately, confidence is waning that this inflection point will materialize—because of the change in political will when it comes to addressing climate. Given that the world’s ability to stay within a 1.5°C pathway was on a knife‑edge, even before the change in U.S. policy and the European shift toward competitiveness, it is entirely understandable why the narrative around climate change is so soundly negative. Because media coverage is focused on not meeting 1.5°C alignment and the consequences this will have on the environment and society, less focus is placed on where progress is being made and what that means for the coming years. The subtext is that achieving 1.5°C alignment will yield a binary outcome, which is true but does not necessarily capture the whole story.

The dynamic driving the narrative brings up an interesting aspect of the energy transition—namely that it involves so many different types of stakeholder groups (governments, corporations, financial market participants, scientists, academics, nongovernmental organizations, activists, and the general population). This collective group of stakeholders has consolidated around the United Nations COP (Conference of Parties) process and sees that the pathways to align to 1.5°C are becoming extremely narrow, with the consequences of not aligning described as potentially catastrophic. Galvanizing attention on this binary narrative serves the purpose of highlighting the need for policy change.

"...the world’s ability to stay within a 1.5°C pathway was on a knife-edge, even before the change in U.S. policy and the European shift toward competitiveness...."

However, in a way, it is a less helpful way to frame the energy transition from the investor’s standpoint. The reality is that getting three-quarters or even one-half of the way to 1.5°C alignment is a massive fundamental shift in the way the global economy is consuming energy. Losing a strong political mandate is clearly negative, and sentiment certainly should be worse without it. However, sentiment may be excessively negative and failing to recognize some fundamental changes to the nature of green infrastructure investment (e.g., scale and cost) as well as its synergies with key priorities, such as energy availability and security.

Decoupling CO₂ and GDP

Energy demand is strongly tied to gross domestic product (GDP) as it is essential for industrial activity, transportation, and generally higher standards of living. Given that global energy systems are dominated by fossil fuels, CO₂ emissions have also been intrinsically linked to GDP. Breaking this link has been reliant on three major factors—the first is improving energy efficiency,³ the second is a shift to electrification, and the third is a shift to zero-carbon energy sources. (A fourth, carbon capture, also has the potential to be deployed at scale, although that is less economically viable without government intervention.)

Since 1990, energy efficiency has improved by around 40% and electricity has grown at a rate more than three times faster than other forms of energy to go from less than 15% of primary energy demand to well over 20%.² Within electricity grids, clean power has taken more share—in 2024, hydro, nuclear, wind, solar, and other renewables accounted for 40% of global generation.² The penetration of clean energy sources varies substantially by region, but even in the most progressed places, they only account for just over 30% of primary demand on average. In the two economies with the largest energy demand (China and the U.S.), they are shy of 20% of primary demand.⁴

Over the coming decade, we expect the “next act” of the energy transition to be driven by solar, electric vehicles (EVs), and heat pumps. The solar story is driven by its competitiveness on the cost curve, whereas EVs and heat pumps will help on the shift to electrification. Over the long run, we expect that nuclear will also play a major role, but incremental nuclear capacity will likely not be able to make a meaningful dent in primary energy demand until 2035 and onwards, given the long lead time required and the high cost of construction experienced in the Western world.

Decarbonization efforts will likely be bundled with other motivations

Put simply, there are two levers to achieving energy transition:

1. Low- and zero-carbon energy economically outcompeting fossil fuel energy
2. Policy intervention

Historically, fossil fuels have won on the economic front, so policy intervention has been the key lever to drive progress on energy transition. While there has been a lot of intervention to date, it has for the most part stopped short of taking decisive action that would increase energy prices to consumers or substantially reduce economic competitiveness. In the U.S., the Inflation Reduction Act very successfully spurred investment into green activities through incentives, but that type of policy maneuver is difficult for governments to implement and maintain.

In our view, carbon taxes are the most fiscally feasible policy lever for most governments, but we recognize that very few have the political will to implement them at a high enough level to drive material change. In our opinion, any material policy intervention that impacts energy transition is likely going to be bundled with other motivations. Those motivations will vary by region, but we believe that energy security will be the most influential over the next three to 10 years.

Growing synergies between climate, energy security, and affordability

Energy security is defined as uninterrupted availability of energy at an affordable price. It is a broad concept that can relate to geopolitical, domestic, or any other type of supply risk and it can refer to a short- or long-term time horizon. It is one of the three factors underpinning the energy trilemma—a framework highlighting the three core factors that policymakers and energy providers must balance (security, affordability, and environmental sustainability).

Looking at the dynamics of the energy trilemma over the past two decades, the environment enjoyed a prolonged period of favoritism during the low-interest rate period, but this shifted toward affordability when inflation and then interest rates started to rise in 2021 and shifted again toward security after Russia’s invasion of Ukraine in 2022. Further geopolitical tension since 2022 has only served to reinforce the focus on energy security.

Implied in the energy trilemma is the premise that there is a trade‑off between the three conflicting factors. Historically, this has been a reliable assumption. A shift to affordability meant that renewables and other zero-carbon fuels were too expensive. Similarly, a shift to security put green energy sources out of favor as their higher cost structure was no longer being offset by normally less expensive traditional energy sources (also, renewables were not material enough within energy systems to help alleviate energy supply issues). However, as renewables have evolved, they are no longer isolated to only contributing to environmental sustainability within the energy trilemma. Within specific regions, some green technologies are now also contributors to energy security and/or affordability.

The energy trilemma: U.S. vs. Europe

The U.S. and the European Union (EU) make an interesting comparison when looking through an energy trilemma lens. Both are large emitting economies where the political landscape has dampened regarding climate and turned to toward energy security.

The European decarbonization story became more pessimistic as Russia’s invasion of Ukraine turned the energy trilemma toward energy security in 2022 and then subsequently layered on affordability when the EU Commission shifted its focus on competitiveness in 2024. With many European countries already in the process of phasing out coal generation, and given the long timelines required to add nuclear capacity, natural gas‑fired generation and renewables are the viable options for new capacity additions. Looking through the lens of the energy trilemma, solar energy will screen much better than natural gas as it meets energy security concerns (once installed it is a domestic energy source) and is at the bottom of the cost curve. 

"...the energy security risk the U.S. faces is not related to geopolitics, but instead it is about ensuring that enough energy is available to meet electricity demand."

The U.S. represents a wholly different scenario than Europe. During the Biden administration, the U.S. energy trilemma was tilted toward environment and affordability. While the focus on affordability remains, President Donald Trump has deprioritized environment and a new urgency on energy security has materialized. Because the country is an oil and gas exporter, the energy security risk the U.S. faces is not related to geopolitics, but instead it is about ensuring that enough energy is available to meet electricity demand. This is expected to grow rapidly due to continued electrification of the economy and the growth of data centers related to artificial intelligence. Another differentiating factor for the U.S. is that, while renewables are low on the U.S. cost curve, natural gas-fired generation is the cheapest.

While the removal of renewables subsidies in the “big beautiful bill” passed by Congress in July even further enhances the relative of natural gas-fired generation versus renewables, we believe that U.S. power generation investments will continue to be skewed towards both of these sources. As figure 10 illustrates, both are competitive without incorporating any benefits from subsidies. Additionally, supply chain constraints on gas turbines will limit the amount of new natural gas-fired generation that can be added over the coming several years.

What is the outlook for corporates?

A lot of companies have committed to net zero or other greenhouse gas reduction targets. In Figures 11–13 we illustrate the progress on emissions targets for constituents of the MSCI World Index, under different scenarios. The charts illustrate how companies would be classified in terms of their level of alignment with a 1.5 degree celsius warming scenario—Achieving, Aligned, Aligning, Committed, or Not aligned. Full definitions of these classifications are provided in the appendix.

In Figure 11, our analysis indicates that 76% of the index’s absolute GHG emissions come from companies with net zero targets and 7% are from companies sufficiently progressed in their Scope 1 and 2⁵ GHG emissions reduction plans that they are at least aligning to a 1.5°C trajectory. 

If all companies hit their existing targets, it would result in the index’s absolute emissions reducing by 23% by 2030 and 72% by 2050 (versus a 2020 baseline). However, applying a more conservative scenario, we have probability weighted that the companies in the “committed” category achieve only 50%⁶ of their target. For companies in the “not aligned” category, 2050 emissions are forecast by projecting business-as-usual emissions to 2030, then applying a 25% probability to the difference between these and a 90% reduction from 2020 levels (net zero scenario) by 2050. Based on these assumptions, we calculate a more modest reduction in the index’s absolute emissions of 16% by 2030 and 49% by 2050. 

Using GHG emissions/enterprise value including cash (EVIC) or weighted average carbon intensity (WACI) translates to greater reductions. The difference is largely the base effect in that 2020 EVIC and revenues were impacted by the coronavirus pandemic.

Conclusion

Despite the very negative narrative around progress on energy transition and somewhat prevailing view that it may stall or even reverse course in the coming years, we are less pessimistic. While we expect that the environmental, social, and governance backlash will have some impact on progress, the intersection of climate and energy security has strengthened the fundamentals around renewables. Furthermore, renewables capacity has finally reached enough scale that incremental growth is material to the energy mix. Historically, the market has repeatedly understated the growth and levelized the cost of renewables. With the potential for continued technological advances, renewables could surprise on the upside.

 

Appendix

ESG considerations form part of our overall investment decision making process alongside other factors to identify investment opportunities and manage investment risk. At T. Rowe Price this is known as ESG integration. As part of our wide range of investment products we also offer products with specific ESG objectives and/or characteristics.

 

Glossary

Net zero status

Net zero status indicates the level of alignment a company has with a 1.5°C warming scenario. The net zero status alignment scale includes:

• Achieving: Company is already achieving the emissions intensity required by the sector and regional pathway to stay within a 1.5°C warming scenario, and its ongoing investment plan or business model is expected to maintain this performance
• Aligned: Company has a 2050 net zero target that is supported by 1.5°C aligned short- and medium-term targets, exhibits GHG emissions intensity performance in line with its targets, and has a credible decarbonization plan and capex alignment
• Aligning: Company has 1.5°C aligned short- and medium-term targets and has a credible decarbonization plan
• Committed: Company has a 2050 net zero target
• Not Aligned: Company does not have adequate GHG reduction targets, disclosure, or performance to qualify for Achieving, Aligned, Aligning, or Committed status
• Out of Scope: Asset class is not yet covered by Paris Aligned Investment Initiative (PAII) Net Zero Investment Framework
• No Data: No data available. Issuer does not disclose enough data, or it has not yet been evaluated

Paris Aligned Investment Initiative net zero framework

Please refer to parisalignedassetowners.org/media/2021/03/PAII-Net-Zero-Investment-Framework_Implementation-Guide.pdf for more information.

Science Based Targets initiative (SBTi)

Please refer to sciencebasedtargets.org for more information.

Scope 1, 2, and 3 greenhouse gas emissions

Corporate greenhouse gas emissions are broken down into Scope 1, 2, and 3, where Scope 1 and 2 emissions represent those under the company’s direct control and Scope 3 emissions represent those in a company’s upstream and downstream value chain.

• Scope 1 refers to all direct emissions
• Scope 2 refers to indirect emissions from consumption of purchased electricity, heat, or steam
• Scope 3 refers to other indirect emissions not covered in Scope 2 that occur in the value chain of the reporting company, including both upstream and downstream emissions. Scope 3 emissions could include the extraction and production of purchased materials and fuels, transport‑related activities in vehicles not owned or controlled by the reporting entity, electricity‑related activities (e.g., transmission and distribution losses, outsourced activities, and waste disposal).